Money down = bad, a myth?

[supercharger]

G:

My buddy and I had a discussion on leasing the other day. I told him what you've been preaching all along: no money down and max out MSD because in the worst case scenario you'll get your MSD back no matter what. He said the concept is wrong because most luxury leases come with gap insurance these days. It's what the gap insurance is for if there's any "gap". He said you'll still get your money down back regardless.

Any thoughts?

[ridewithg]

I think your buddy may have a misconception about what GAP really does. GAP only covers what you owe the bank in the event of an accident. What you owe isn't really the payments, but the difference between the "market price" and the the payoff amount at the time. When you put money down, that money gets spread across 36 months to lower your monthly payments, but it doesn't change the residual/payoff. Think of it as a prepayment of your loan to lower the loan size. So whatever money you put down, pretty much disappears in the event of an accident.

[tytek]

While I agree with G for the most part, a lot depends on what kind of a total loss it is.

If the car were stolen or totaled , most likely, with GAP coverage or not, your insurance company will give you a market value of the car as it stood prior to the tragic event. If you put a lot of money down to buy down the payment, what you owe to the bank will be less than the market value... whatever is left over from paying down the bank's loan, is yours to keep. You will obviously lose the difference of what you put in vs what the car is worth according to the insurance provider. But the same is true when buying a car, instead of leasing. Without GAP, you may even have to pay out of your own pocket for market value to loan value delta. So GAP is always important, especially in a lease, especially when you put little down. The lease benefit of paying little down limits your exposure to such loss.

But, in case of another scenario, when your leased car is totaled due to a third party (not your fault) you always have the ability to sue to offending party and their insurance company for all the money you have lost: market value, downpayment and all other costs that you had to pay. Some states, Georgia for example, have a diminished value law that requires the insurance provider to pay the insured the difference between totaled value and value prior to the incident.

So like everything else in life, things all depend on the scenario. In most cases, however, it is better not to put too much down on a lease, if you can stomach the large payment.

[ridewithg]

i agree with tytek on most points he covered with the exception of how the down payment affects the GAP. Your lease payments are based on the total depreciation within the first 3 years. So the payments are derived from the average monthly depreciation over 3 years (plus fees and taxes). Unfortunately, cars do not depreciate equality from month to month, therefore losing your car within the 1st year and 2nd year of leasing will more than likely eat away at that a significant chunk of that down payment. If you had more miles that you were supposed to, you will probably lose that much more market value on that car. Another thing is that residual are ESTIMATED values over the course of 3 years. If for any reason, the market value of your lease drops (or increases) a few months or a year from the time you started your lease, that will affect the difference between the payoff and what an insurance company would offer on a lost vehicle. Residual values have been historically inflated to provide lessees with lower monthly payments. Therefore, market value will more than likely be significantly lower than the payoff if you are averaging your contracted miles. Currently, residual values are coming down a bit, making the residual values closer to the market values, but I don't think they are quite there yet.

[tytek]

That's right G. Cars do experience rapid depreciation during their first year. That depreciation slows down as the vehicle ages and accumulates average miles. I decided not to put that statement in my above post, but it was assumed in there (but not implied ). That is the primary reason to have GAP insurance - you can even cancel it for the last year or so of your lease or loan (on average) and you will not lose much in case the car becomes a total loss or gets stolen and shipped overseas.

However, depreciation does not apply to leasing if you put little down and have GAP coverage. I think we both agree on that, Mr. G!

BTW, great point on the residuals, especially since most (on attractive leases) are subsidized by the manufacturers. The reality is often a lot more bleak.

[ridewithg]

Haahaa. I guess in the end, we where both talking about the same thing. Good stuff.
I think folks need to be super careful as to how they choose to pay. MSDs are really a great alternative to lowering payments without the risk of having you lose any of it. Of course, me being me, I wouldn't lease a car who's MF is so high that I had to put MSDs since I like having my cash in my pocket and bank account instead. Heehee

[simracer]

With all of the "not so good" money factors out there on some of the more popular vehicles, it sounds like the MSD route is still the better option for those not wanting huge monthly payments and down payments. Do all dealers typically accept an MSD as an alternative to a down payment? How many MSD's is one allowed? I like the idea of reducing my monthly payments and not basically prepaying with the down payment option.

[ridewithg]

Not all banks do MSDs, but most luxury brands do. You have to ask since dealers generally prefer to get you to put money down instead. In my experience, I think most dealers would rather put you in a cheaper lease using cap reduction than a slightly more expensive one using MSDs. I think the amount allowed varies. I have heard up to 7 for BMW.

[tytek]

It is 9 times the SD for Lexus... MF drops from .002 to .00128. Which ain't bad if you don't mind parking some cash - liquid investments offer a dismal return right not anyways, might as well reduce your interest exposure.

But like with anything, it comes down to the bottom line. If you save more by investing that cash in a CD at a higher rate than what you'd save on the MF (and tax), then go that route.

[delta737h]

I do not advise making a cash down payment (i.e., cash cap reduction). A car is a depreciating asset and is purchased for consumption; and so, it's an expense and not an investment. No savvy investor would ever invest in stock that they know will depreciate or lose value over time. Also, if the vehicle is lost or stolen and never recovered, the insurance carrier will only pay ACV (actual cash value or est. market value). If your lease balance exceeds the ACV (called the GAP), your GAP protection will cover the difference. This GAP narrows the larger the down payment. Large down payments can cause the ACV to exceed the lease balance (negative GAP). In such cases, you necessarily risk losing part or all of your cap reduction if your car is totaled or stolen but never recovered.

It might be helpful to remember the following before deciding to make a cash down payment (i.e., cap cost reduction)...

If the GAP equals or exceeds 0, then you owe nothing and receive nothing. However, you've lost your entire cap reduction or down payment. The insurance company will pay the fund provider the ACV and the GAP carrier will pay the fund provider the difference between the amount owed (lease or loan balance) and the ACV. And so, the fund provider doesn't lose; you do!

If GAP < 0, then you'll receive, from the fund provider, the difference between the ACV and the lease balance or loan balance less any transaction costs incurred by the fund provider. However, this may not be sufficient to cover your cap reduction or down payment. In which case, you would lose the difference. The only thing the fund provider wants is the outstanding balance owed plus any transaction costs. You, of course, get whatever remains (the scraps so to speak).

One other thing... never buy GAP insurance from a dealer if the fund provider doesn't offer it in their lease contract, or provides it at additional charge, because the cost is inflated by about 1000%! Check with your insurance carrier and, whether you buy or lease, your carrier can attach a GAP rider to your existing insurance policy. The annual cost, as a rule of thumb, is roughly 0.1% of the vehicle's MSRP. So, if the MSRP is $49,000, then your annual GAP premium is roughly...
0.1% x $49,000 or about $49 annually.

John